Wednesday, October 9, 2013

Margins on Exchanges

A nice Bloomberg View by David Goldhill offers an Econ 101 lesson in incentives. Though the average subsidy rate to health insurance is limited, the marginal subsidy rate is 100% once consumers hit the income limits -- so many consumers have no incentive at all to shop for lower prices. In turn, this greatly lowers the chance that insurers will compete on price.

David:

Let’s take an example. A family of four at 138 percent of the poverty level ($32,499) has its premium capped at 3.29 percent of income or $1,071. The rest is subsidy. So, if the cost of a silver plan is $10,000, the subsidy for this family is $8,929. A family at 400 percent of the poverty level ($94,200) has to pay up to 9.5 percent of its income for a plan, or $8,949. So the same $10,000 premium carries a subsidy of only $1,051.

But now look at those two families from the insurer’s perspective. A $10,000 plan already costs more than the maximum amount either family would pay. If the insurer raises the premium to $10,001, both families get $1 in additional subsidy. If it raises premiums to $11,000, both families get $1,000 in additional subsidy. In other words, no matter how much an insurer raises rates, a subsidized household pays zero more.

Of course, it takes some cleverness for insurance companies to separate out these now totally price-insensitive buyers from regular customers, and David explains some of the ways they can do so. Having seen the airlines at work, you get a sense of just how clever companies can be. Modern big-data driven marketing is all about careful price discrimination.

A more well known incentive problem: A rule that you must spend 80% of what you take in can limit profits. Or it can incentivize wasted spending.

In what may be the single greatest source of unintended consequences in the Affordable Care Act, insurers are now required to spend at least 80 percent of revenue from premiums on care. Superficially, this means that if they set premiums too high, they will have to eventually refund much of the money that they don’t end up spending on care. But let’s say you’re running an insurance company. You can find ways to spend more money on beneficiaries’ health care -- say, with more generous definitions of free preventive care, more expansive rehabilitation services or higher reimbursement rates on doctors’ services -- and keep 20 percent of the all money you bring in. Or alternatively, you can spend less on care and give refunds. Easy choice.

Update: I don't know why I didn't think of this before... Cash rebates! Just like credit cards. OK, we can't be so obvious, points on your credit card, free miles, toasters, checkups for your cat...Each dollar added to the premium comes from the government, so attract customers by the closest thing you can get away with to cash back.

If you read the article, anon, they do care how much they pay, but they don't care how much the insurance company charges because the family in question just gets subsidized more if they pick a more expensive plan. So they won't care if the silver plan costs 10 thousand or 11 thousand. The family pays the same either way. If they did care, competition would work, but they don't, so it won't.

The point is that they don't care what the actual price is beyond $1,071. It could be $2,000 or $20,000 but to them it's still just $1,071, so why should they shop around?

You see this phenomenon already with co-pays. For example, people don't care what a drug really costs because for them it's a $20 co-pay. The only time they complain is when the insurance co-pay is higher for a certain "tier" of drugs.

For people in this situation the differentiator will be service-related: which plan hassles them the least, provides access to more doctors, etc.

Anon - That $1000 does not change based on the premium, within the relevant range--it's based on the insured's income. The only way for an insurance company to compete for this customer based on price would be to have a premium that is less than $1000 total, which is unlikely.

Goldhill fundamentally misunderstands how the exchanges work. The subsidies are based on on second cheapest silver plan. The marginal subsidy is zero. If consumers chose a more expensive plan they pay the entire price difference on top of the affordable amount that they have to pay for the second cheapest silver plan. If they chose a cheaper plan, they pay LESS than the affordable amount determined by their income.

Just like a regular market, insurers have incentives to lower prices to attract consumers. (They could collude, but that's true in any market, not a function of the exchange.)

There is some distortion from the price subsidy (e.g. if bronze plans are so cheap that the premiums consumers face hit the zero lower bound), but it is not nearly as bad as Goldhill claims it is.

John,I've argued the negatives effects of the 80/20 law when discussing the ACA. Its seems to me that competition among insurers will not be enough to counteract their common incentive to keep costs as high as possible. However, I am no economist. I'd love to hear your take on how these forces will play out.

At least the "Obamacare" debate is FORCING a national, all at once, collective discussion on what healthcare should cost at all. Everyone on a level platform. It's the step 1 towards a universal option.

Let the wealthy keep their diamond healthcare plans (and pay through their nose) if it suits them. Fair enough. But healthcare for EVERYone else needs to come DOWN in price.

Thanks to a few abusers I am now moderating comments. I welcome thoughtful disagreement. I will block comments with insulting or abusive language. I'm also blocking totally inane comments. Try to make some sense. I am much more likely to allow critical comments if you have the honesty and courage to use your real name.

About Me and This Blog

This is a blog of news, views, and commentary, from a humorous free-market point of view. After one too many rants at the dinner table, my kids called me "the grumpy economist," and hence this blog and its title.
In real life I'm a Senior Fellow of the Hoover Institution at Stanford. I was formerly a professor at the University of Chicago Booth School of Business. I'm also an adjunct scholar of the Cato Institute. I'm not really grumpy by the way!